Futures and Options (F&O)

 

When someone is new to the stock market or trading in stocks, they often encounter difficulties in understanding futures and options. To simplify, consider a scenario where an investor is just starting to trade in the stock market and wishes to learn about futures and options. Suppose the investor decides to invest in shares of a specific company. They buy 250 shares of that particular company at a value of Rs. 28,000. The total value of the shares is now Rs. 7 lakhs, signifying that the investor has invested 7 lakhs rupees.

If the share price goes up by, let's say, Rs. 100, the investor would make a profit of Rs. 25,000. However, in the volatile stock market, it's not always guaranteed that prices will go up; sometimes they may go down. In situations such as war or international crises, it's entirely possible for the market to decline. If the market crashes or experiences a downturn, and the price of those particular shares is halved to Rs. 14,000, the total value of the investor's shares would be reduced to Rs. 3.5 lakhs, compared to the initial 7 lakhs invested.

In such situations, an investor may experience emotional distress, which could manifest as conditions like hypertension. This is where futures and options come into play, particularly in terms of hedging, which means protecting yourself from losses. To put it simply, there are two main categories to understand: Options and Futures. Let's begin by discussing the first category, which is Options.

Options:  In options trading, there are two methods known as "call" and "put." A "call option" is used when an investor anticipates that the market will rise, while a "put option" is implementing when someone assume the market will decline. To illustrate, consider buying a lot of 10 options with a share value of 250. This means the total investment is Rs. 2,500, but it's important to note that you're not purchasing physical shares; instead, you're acquiring a put option. Think of it as insurance for your investment.

Here's how it works: If the market goes down, meaning you initially invested Rs. 2,800 per share, and the price drops by Rs. 100, the shares are now worth Rs. 2,700 each. Conversely, the value of the put option increases simultaneously. So, if you experience a market loss of Rs. 25,000, the put option helps cover that loss. This is the basic mechanism of how options work. Options are typically used for short-term hedging.

Conversely, the opposite strategy is a "call option." A call option is chosen when an individual expects the market to go up in value.

Future:  In future method, investors can utilize leverage to their advantage by committing a relatively small amount of capital to control a larger position. To illustrate this concept further, let's revisit the previous example to demonstrate how one can employ leverage in a specific trade.

Suppose an individual has 1.5 lakh rupees and wishes to trade or purchase 250 shares with a total value of 7 lakh rupees. With the use of futures and options, they can potentially acquire shares worth 6 lakh rupees, which is 3 to 4 times the value of their existing assets.

If the share prices increase, let's say from Rs. 2800 to Rs. 3000, this would result in a profit of Rs. 200 per share. Consequently, the total profit generated from 250 shares would amount to 50,000 rupees, all achieved with an initial investment of only 1.5 lakh rupees. This explain the leverage offered by futures and options in trading.